February 1, 2011
2010 proved to be a record year for the credit markets, as companies easily issued debt at record low borrowing rates. Investors, wary of near zero government interest rates started chasing yields in corporate bonds and thus allowed companies to raise capital at rates they had never seen before. These companies now stand vulnerable however, as most of the capital raised was used to pay down existing obligations or extend maturities and just added risky debt to their balance sheets. WSJ reported.
About 59% of risky debt raised last year went toward such refinancing, Moody’s found. Nearly a quarter of the money raised financed mergers and acquisitions as deal making picked up.
Moody’s said that almost $700 billion of this debt is set to mature in the next five years, and there are many risks that companies face in being able to refinance this debt. One of the bigger risks is an increase in interest rates. These companies were able to issue bonds at around 8% as investors chasing yields pushed rates lower. But increased rates could shoot up refinancing costs for these companies. The complete report from WSJ is below -
A record year for credit markets helped weaker companies refinance their obligations. But the amount of risky debt on their books hasn’t changed much, leaving the companies vulnerable.
Moody’s Investors Service warned Monday that the riskiest companies—those with speculative-grade or “junk” credit ratings—cut their total obligations by only about $100 billion during the mania that gripped high-yield bond and leveraged-loan markets last year.
Companies “kicked the can,” according to Moody’s, using the new capital mostly to pay down existing obligations or extending maturities. The moves didn’t remove much of the weight from their balance sheets.
About 59% of risky debt raised last year went toward such refinancing, Moody’s found. Nearly a quarter of the money raised financed mergers and acquisitions as deal making picked up.
The upshot is that nearly $700 billion of risky debt still is set to mature over the next five years, Moody’s said, which could cause trouble for companies looking to refinance and avoid default. Much of the debt traces back to the leveraged buyout boom fueled by private-equity firms before the market crashed.
The credit-rating firm’s annual report on risks faced by roughly 1,000 nonfinancial companies with weak credit ratings concluded that the market should be able to handle the so-called refunding requirements, assuming no significant economic shocks occur.
Still, risks remain since some fundamental market drivers could change. Interest rates, now near zero, are likely to increase, which could cool investor appetites for riskier debt such as junk bonds. In the last two years, investors chasing yield have flocked to junk bonds, where rates around 8% have trumped returns they can find elsewhere.
For companies, the demand has allowed them to raise new capital more cheaply, since junk bonds usually command interest rates higher than 10%. Firms issued more than $200 billion in junk bonds last year, according to Moody’s, up from $138 billion in 2009 and $49 billion in 2008.
Refinancing later could be much costlier if rates move higher. “It’s going to be a very big risk,” said Kevin Cassidy, a Moody’s vice president. “They may need to refinance at a time when the interest rates are so high that they can’t take that kind of interest carry.”
That could cause trouble for firms deep in junk territory with debt-laden balance sheets. Companies in the hotel, gaming and leisure sectors remain most vulnerable, Moody’s said. Telecommunications, media and tech firms, meanwhile, hold the largest amounts of debt coming due through 2015-$159 billion, or nearly a quarter of the total. For roughly three dozen companies that have struggled over the past two years and have due dates drawing closer on their debt, any hiccup in the markets could be “fatal,” Moody’s said.
Those companies include Texas Competitive Electric Holdings Co., a Dallas subsidiary of Energy Future Holdings Corp. with more than $28 billion in rated debt coming due in the next five years; Caesars Entertainment Corp., the Las Vegas casino operator once called Harrah’s, with $7.5 billion in looming debt maturities; and US Airways Group Inc., with maturities of $1.2 billion, according to Moody’s.
An Energy Future spokeswoman said the company has minimal debt maturities until late 2013 and early 2014 and has made progress under a liability management program with $1.6 billion in net debt reductions and $4.1 billion in debt-maturity extensions. The company continues to “monitor market conditions and explore available opportunities to take further action,” the spokeswoman said. A Caesars Entertainment spokeswoman said the company has no “meaningful maturities” until 2015, giving it “sufficient time and opportunity to refinance.” US Airways didn’t respond to a request for comment.
Moody’s said near-term refinancing needs are modest, with just $26 billion maturing this year and $67 billion in 2012. Still, those numbers could increase amid a so-called “pull-forward” effect in which companies refinance one piece of debt and use the opportunity to rework other obligations that mature later.
That phenomenon could pull $166 billion in maturities forward to 2011 through 2013. Overall, companies could feel the need to rework $395 billion in bank and bond debt over the next three years instead of the just $229 billion that comes due.
Other risks include “contagion,” or the spread of financial woes elsewhere to credit markets. Moody’s pointed to Greece’s sovereign-debt problems as an unnerving event that caused the high-yield market to slow in mid-2010. Antigovernment protests in Egypt have more broadly rattled markets in recent days.
Some risky firms have less dire outlooks but still face significant refinancing needs. Just 10 companies account for nearly $110 billion of the debt coming due in years ahead, with Texas Competitive Electric Holdings, First Data Corp. and HCA Inc. leading the pack. All three were bought by private-equity firms in LBOs.
First Data and HCA declined to comment.
Another risk for companies looking to restructure: A shift in debt from leveraged loans to junk bonds. Companies often have relationships with banks that are willing to help them through troubles, Moody’s Mr. Cassidy said.
But with bonds dominating more balance sheets, less-patient hedge funds could start cropping up more in restructurings. These investors often look to buy debt at distressed prices and then take ownership of companies by converting their obligations. “If they’re buying a lot of the lower-rated debt and want the equity, they could throw it into bankruptcy,” Mr. Cassidy said.
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